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Thank The House For Rejecting an Ill Conceived Plan

Although markets might be shook up for a few days, the country owes the House of Representatives a big thank-you for standing in front of the Bush administration's bailout freight train.

This plan was poorly conceived. Many of its parts were self-defeating.

When the plan was first announced, it was widely denounced as a $700 billion blank check to Treasury Secretary Henry Paulson. As voted on in the House, it had been reduced to a $350 billion blank check. But it took another vote in Congress to prevent him from getting the additional $350 billion.

The legislation purported to instruct the treasury secretary to buy distressed securities at the lowest possible price for taxpayers, using market mechanisms such as a reverse auction.

However, the bill also required that the secretary obtain warrants for stock in the companies whose distressed securities were being bought. The warrants were to be for whatever percentage of the company the secretary decided, at whatever price the secretary set.

This pretty much obviated the reverse auction idea. How would a company know how much of a discount on its securities to bid if it didn't know how much of the company the government would demand in exchange and what the company would get for that dilution of shareholder equity?

As a practical matter, the bill would have returned Paulson to his make-a-deal mode with individual companies, as the bill also permitted, playing with a very big pot of taxpayer money. There's nothing in Paulson's record to date to suggest that he - or any other treasury secretary for that matter - should be entrusted with that kind of power.
There are tough economic times ahead. The country has overinvested in housing and overborrowed in general.

Some of what is triggering panic is actually a necessary or beneficial part of the correction.

Weaker and more leveraged financial institutions are being taken over by stronger institutions that behaved more prudently.

If the country has overborrowed, the volume of credit needs to shrink. That requires tighter lending standards and higher interest rates.

At this point in the correction, the corporate prime rate is at 5 percent and corporate bonds at an average of 7.2 percent. The country isn't really staring into the abyss of the 1970s, when interest rates reached double-digits, much less the Great Depression, during which the economy contracted by 40 percent, stocks lost more than two-thirds of their value and unemployment reached 25 percent.

Still, there is an overwhelming consensus that Congress needs to pass something. If that consensus is to be acted on, here's a program that matches the moment, both economically and politically.

First, Congress should suspend the mark-to-market accounting rule for mortgage-backed securities. This requires MBSs to be booked for the highly discounted price at which they can currently be sold, not the much higher price they are likely to be worth if held to maturity.

The bill rejected by the House would have empowered the SEC to suspend the rule. Instead, Congress should mandate it. This would provide virtually as much balance sheet relief as Paulson's proposal that taxpayers buy the MBSs.

Second, enact the House Republicans' idea for the federal government to insure MBSs. Paulson says it won't work. But he would have a hard time explaining why companies pay trillions for such private insurance but won't purchase more secure insurance from the federal government.

Third, have the federal government guarantee the refinancing of homes based upon extending the life of the mortgage for as long as it takes, even if well beyond the conventional 30-year period, to reduce monthly payments to a certain percentage of income. With such a program, no one would have to lose their home, lenders wouldn't have to take a hair cut, and, given the income requirement, federal outlays would be minimal.

This program relieves the credit crunch caused by artificially depressed MBSs as much as the federal government is capable of doing. It doesn't fundamentally change the role of the federal government in the private economy, as House Republicans fear. It helps homeowners, as Democrats want.

And it doesn't put taxpayers at considerable risk to bail out imprudent big-boy investors, as a remarkable coalition of independent-minded Democrats and conservative Republicans commendably called a halt to on Monday.

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